Chronic Macro-Economic and Financial Imbalances in the World Economy: a Meta-Economic View

Brazilian Journal of Political Economy, vol. 35, nº 2 (139), pp. 203-226, April-June/2015 Chronic macro-economic and financial imbalances in the world economy: a meta-economic view ROBERT GUTTMANN* Global finance, combining offshore banking and universal banks to drive a broader globalization process, has transformed the modus operandi of the world economy. This requires a new “meta-economic” framework in which short-term portfolio-investment flows are treated as the dominant phenomenon they have become. Organized by global finance, these layered bi-directional flows between cen- ter and periphery manage a tension between financial concentration and monetary fragmentation. The resulting imbalances express the asymmetries built into that tension and render the exchange rate a more strategic policy variable than ever. Keywords: global finance; monetary fragmentation; hot-money flows; meta-economic framework; exchange rates. JEL Classification: F32; F33; F44. The world economy witnessed widespread and thorough deregulation of exchange rates and cross-border capital flows during the 1970s and 1980s, a period that saw also a major conservative policy revolution in the wake of the Reagan and Thatcher administrations ruling the two countries with the world’s largest financial centers. “Reaganomics”, combining massive tax cuts for the wealthy, deregulation, privatization, cuts in public-assistance programs, weakening of unions and collec- tive-bargaining rights, was given an international reach as the so-called Washington Consensus being imposed on developing countries in return for assistance by the IMF and US Treasury for their crisis-ridden economies. This worldwide push for free-market reforms, phenomenally successful in its planetary propagation, has offered an excellent test case for the efficacy of market-regulated adjustment mechanisms. Yet the results have been disappointing, with macro-economic and financial * Professor of Economics, Hofstra University and Université Paris XIII. E-mail: robert.p.guttmann@ hofstra.edu. Submitted: 21/July/2014; Approved: 31/July/2014. Revista de Economia Política 35 (2), 2015 203 imbalances growing in size over those decades and showing remarkable stickiness that has defied their easy resolution. Neither flexible exchange rates nor changes in the policy mix seemed to have been able to reduce or eliminate external imbalances in lasting fashion. Only crises, of which we have seen many instances over the last four decades, did make a dent in those imbalances in relatively speedy and durable fashion. This empirical reality defies the standard macro-economic paradigm, always a good starting point for heterodox alternatives to challenge the established dogma with a better explanation. But such an opportunity will only succeed, if that theoretical alternative can come to grips with the deep structural changes our world economy has experienced since the early 1970s. There are in particular two transformations we have to take account, the intense wave of globalization sweeping our planet and the explosive growth of financial transactions in its wake. If we can take better account of these crucial phenomena than the standard approach has done so far, then we shall have opened the way for giving our explanations greater credibility while also improving our understanding of major challenges we face today. This paper is a small attempt in the direction of such theoretical innovation to explain the persistence of external imbalances and their connection to crisis dynamics. DEFINING IMBALANCES AND ADJUSTMENT Paths When macro-economic argumentation applies to open economies, it expands our understanding of a national economy’s behavior by moving us beyond the domestic dual balance of private sector (savings S, gross business investment Ig) and public sector (taxes T, government expenditures G) to include an external sector (exports X, imports M) through which that economy is linked to rest of the world. From the essentially Keynesian spending/product equation Y (GDP) = C + Ig + G + X and the income equation Y = C + S + T + M, and denoting Xn as net exports (X – M), we get: Xn = (S – Ig) + (T – G) The three sectoral balances are thus intertwined so that changes in one balance will beget compensatory changes in the other balances. For instance, a trade (or current account) deficit (Xn < 0) may well be the result either of a private-sector deficit (Ig > S) and/or budget deficit (G > T) or a combination of both. One way to reduce such an external imbalance is to tackle the imbalances at home. You can get current account deficits under control by applying fiscal austerity to get budget deficits pushed onto a downward path — a policy prescription the 18-member eurozone seems to be very fond of these days.1 It is more difficult to do that by 1 The “fiscal pact” of 2011 holds eurozone members to a more strictly enforced budget-deficit limit of 3 percent of GDP than had been hitherto the case, and gives the European Commission the authority 204 Brazilian Journal of Political Economy 35 (2), 2015 • pp. 203-226 changing the parameters of the private sector even though monetary policy aimed at altering interest rates in prescribed doses may impact on savings and/or on in- vestments both of which are (somewhat) influenced by interest rates. We can also take a more pro-active view in which the external balance, best measured in the broader sense of a currentaccount balance (adding repatriated investment income and unilateral transfers to the balance of trade in goods and services), is no longer just seen as a passive residual of the private- and public- sector balances at home. Instead it becomes a self-determined balance, which after half a century of rapidly expanding trade volumes across the capitalist world hav- ing rendered a large majority of countries so much more dependent on trade may ultimately be a sensible assumption. Trade has become so important to the fortunes of the domestic economy, even in a relatively closed economy like the United States whose foreign-trade share of exports and imports in GDP rose from about 10 percent in the mid-1970s to 28 percent last year. Most countries, smaller and under more pressure to specialize, have far greater degrees of openness however, ranging from 60+ percent in Germany to over 100 percent in, say, Belgium or the Netherlands. And just as the external balance has become increasingly autonomous with growing self-determination in the wake of globalization, so has it also gained its own adjustment mechanism to move us beyond its traditional (passive-residual) dependence on corresponding changes in the domestic S — I and T — G balances. Ever since the US introduced a free float for the US dollar in March 1973 following the collapse of the fixed exchange rate regime known as Bretton Woods in August 1971, the world has moved gradually towards market-determined “flexible” exchange rates. Much of that movement towards greater currency-price liberalization occurred in the wake of recurrent currency crises triggered by successful speculative attacks on unsustainable “pegs” (i.e., fixed-rate currency anchors) as happened in the wake of the LDC debt crisis of 1982-89, the disintegration of the European Monetary System’s fixed-rate Exchange Rate Mechanism in 1992-93, the “Tequila crisis” of the Mexican peso in 1994-95, or the “Asian Tigers” crisis of 1997-98. With varying degrees of float now the standard, deficit countries can try and let fluctuations in their exchange rates correct these external imbalances. Facing excess supplies of their currency (as the external deficit translates into net outflows), they will see it depreciate whereby imports are rendered more expensive and exports become more price-competitive. These price effects from a currency depreciation should lead to volume adjustments towards more exports and fewer imports, re- storing so balance in the current account. Yet, when we look at the global statistics collected by such multilateral institu- tions as the International Monetary Fund and its World Economic Outlook, we see persistent current account imbalances among leading (G-20) countries as well to review member’s budget plans with active sanction power. Its enforcement can at same time be tailored to the specific needs of individual members. Revista de Economia Política 35 (2), 2015 • pp. 203-226 205 as between or within regional blocs persist over many years. These may range from 2 percent to 6 percent of GDP, more pronounced in some countries and definitely also subject to considerable cyclical fluctuations. As a matter of fact, the prevailing state of the cycle has a consistent impact on a country’s current account. During recoveries current account balances tend to deteriorate as imports often rise dis- proportionately (as the tend to have higher-than-average value added) in line with growing aggregate spending in the economy while exports rise less amidst a thriv- ing home market. This inverse relation between domestic expansion and the current account gets stronger, the faster the growth. Part of that is also due to parallel changes in the domestic balances towards greater private-sector deficits (as S slides proportionately while I picks up) outweighing gradual improvements in the public sector due to growth-enhanced tax revenues. The opposite happens when the economy turns down, with current account deficits typically shrinking swiftly. Apart from these cyclical fluctuations, we do however see stubbornly persistent, hence chronic current account disequilibria. America’s lasting trade deficit or the large current account surpluses of China, Germany, or Japan are much-noted examples proving that point, and there are many other examples less well known. This persistence of external imbalances indicates that the aforementioned adjustment mechanisms do not work as they should. Yes, it may be politically too difficult for governments under pressure to impose fiscal austerity on its citizens.

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